Professional Documents
Culture Documents
Project Financing
of Infrastructure Project
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PROJECT FINANCE
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Origins and Development of
Project Finance
• Project financing had its origins in the energy industry in
industrialized countries (oil & gas production loans).
• Later extended to infrastructure, transportation, mining,
utilities and large industrial projects.
• Scope further expanded to include all kinds of infrastructure
projects.
• Today even medium-scale projects (US $5 million) can use
project finance
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Development of Project Finance
1994 1996 1997
• Number of Project
Finance Transactions 50 400 380
in emerging markets
• 41% of emerging markets project finance flows between
1994 and 1998 went to Asia.
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Why Project Financing?
• Project Owners’ Perspective
– Size and cost of projects
– Risk minimization
– Preservation of borrowing capacity
and credit rating
– May be only way that enough funds
can be raised
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Private Public Partnerships in
Infrastructure
• A major new user of project financing techniques
• Infrastructure traditionally financed and managed by
governments
• Demand for infrastructure has been growing faster than
available government funding particularly in emerging
economies.
• Recent trend has been to involve the private sector in the
supply and provision of these services
• There has to be a clear benefit for both the public and the
private partners
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Main Characteristics of Suitable
Investments for Projects Financing
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Main Characteristics of Project Finance (Summary)
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The Basic Elements of a Project Financing
Lenders
Loan Debt
Raw funds repayment Purchase
materials contract(s)
• Financial Analysis
• Economic Analysis
• Risk Analysis
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It’s All About Risk!
The key to project financing is
the reallocation of any risk away
from the lenders to the project.
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Definition of Project Completion
• Principle Categories of Risk: Pre-Completion and Post-
Completion
• Physical Completion
– Project is physically complete according to technical design
criteria.
• Mechanical Completion
– Project can sustain production at a specified capacity for a
certain period of time.
• Financial Completion (financial sustainability)
– Project can produce under a certain unit cost for a certain
period of time & meets certain financial ratios (current ratio,
Debt/Equity, Debt Service Capacity ratios)
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Management and Alleviation of Risks
Principle Categories of Risk: Pre-Completion and Post-Completion
A:Pre-Completion Risks:
Some Examples of
Ways to Reduce or Shift Risk
Types of Risks Away from Financial Institution
•Participant Risks
-Sponsor commitment to project - Reduce Magnitude of investment?
-Require Lower Debt/Equity ratio
-Finance investment through equity
then by debt
– Financially weak sponsor - Attain Third party credit support for weak
sponsor (e.g.,Letter of Credit)
- Cross default to other sponsors
•Construction/Design defects - Experienced Contractor
- Turn key construction contract
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Management and Alleviation of Risks
A:Pre-Completion Risks (cont’d):
Some Examples of
Ways to Reduce or Shift Risk
Types of Risks Away from Financial Institution
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B. Post-Completion Risks
Some Examples of
Ways to Reduce or Shift Risk
Types of Risks Away from Financial Institution
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B. Post-Completion Risks
Some Examples of
Ways to Reduce or Shift Risk
Types of Risks Away from Financial Institution
• Market Risk
–Volume -cannot sell entire output - Long term contract with creditworthy buyers :take-
or-pay; take-if-delivered; take-and-pay
–Price - cannot sell output at profit - Minimum volume/floor price provisions
- Price escalation provisions
• Force Majeure Risks
–Strikes, floods, earthquakes, etc. - Insurance
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Some Examples of
Ways to Reduce or Shift Risk
Types of Risks Away from Financial Institution
• Political Risk
–Covers range of issues from - Host govt. political risk assurances
nationalization/expropriation, - Assumption of debt
changes in tax and other laws, - Official insurance: OPIC, COFACE, EXIM
currency inconvertibility, etc. - Private insurance: AIG, LLOYDS
- Offshore Escrow Accounts
- Multilateral or Bilateral involvement
• Abandonment Risk
–Sponsors walk away from project - Abandonment test in agreement for
banks to run project closure based on historical and
projected costs and revenues
• Other Risks: Not really project risks but may include:
–Syndication risk - Secure strong lead financial institution
–Currency risk - Currency swaps / hedges
–Interest rate exposure - Interest rate swaps
–Rigid debt service - Built-in flexibility in debt service
obligations
–Hair trigger defaults
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The Need for Contracts
• Project financing arrangements invariably involve strong
contractual relationships among multiple parties.
• Project financing can only work for those projects that can
establish such relationships and maintain them at an acceptable
cost.
• To arrange a project financing, there must be a genuine
“community of interest” among the parties involved in the
project.
• In must be in each party’s best interest for the project financing
to succeed.
• Only then will all parties do everything they can to make sure
that it does succeed.
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